Google Expected To Buy Waze: Acquisition Analysis

Many companies, including Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB), have been interested in crowd-sourced mapping and navigation service Waze in the past. In January, Apple was courting it with a $500M offer. And since last month, Facebook joined the bid, willing to pay between $800M and $1B. However, according to a report on Sunday from Israeli newspaper Globes, it will be Google (NASDAQ:GOOG) and not Facebook that will announce the acquisition of Waze for $1.3B (this week). It seems that Waze was unwilling to relocate its Israeli-based engineering team to Facebook's headquarters in the U.S.

In this article, we make an analysis of this potential acquisition. We are especially interested in assessing the value that owning the Israel-based startup brings to the table, if we consider that Google already has its own mapping solutions.

The Potential Deal

First, some quick "facts." Notice that almost everything we know about the potential deal is due to the report by Globes. Neither Google nor Waze have confirmed the deal, and as Quartz notes, "observers have reasons to doubt acquisition stories out of Israel lately as a PepsiCo (NYSE:PEP) bid for SodaStream (NASDAQ:SODA) was recently reported but then hotly denied."

Google is to acquire Waze Ltd. for $1.3B.

Facebook was also in talks to acquire the company. Representatives may have arrived in Israel to meet Waze executives, but no deal was reached. This could be either because the price tag was too low or because of Facebook's intentions to move the engineering team to its headquarters. This also suggests that, unlike Facebook, Google is willing to let Waze keep most of its staff in Israel.

Waze was founded in 2009 and in October 2012, it received its first serious round of funding, with a $30M financing round from Horizons Ventures, Kleiner Perkins Caufield & Byers and iFund. So far, the company has raised $67M; from Magma Venture Partners, Vertex Venture Capital, Qualcomm Ventures, BlueRun Ventures and Microsoft Corporation. Therefore, the $1.3B potential acquisition price represents a great exit for Waze as it would turn its founders into multimillionaires.

Waze: Traffic, navigation and mapping taken to their maximum expression

Waze owns an excellent community-based traffic and navigation app (available on the iPhone and Android platforms). Unlike Google Maps, Waze maps can be edited by users. The Waze community is quite active in editing the maps by putting police alerts, accidents, road hazards or traffic jams. This information is shared by other drivers in real time and could be very valuable: some drivers are using it on a constant basis to find the cheapest gas stations in their routes.

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So, the best way to understand Waze is as a Google Maps with a lot of social mechanics and gamification involved. Naturally, this causes users to be more engaged, and although I have not obtained information regarding Waze's engagement metrics, I expect them to be higher than in the case of Google Maps.

However, Google Maps is far superior in terms of reach metrics. To begin with, the Waze project started in 2008. Google Maps, on the other hand, is about 4 years older: it started as a C++ program designed by two Danish brothers (Lars and Jens Rasmussen) at the Sydney-based company Where 2 Technologies, which was acquired by Google in October 2004. Also, it is important to note that the Google Maps rich API allows many developers to use Google Maps in their applications, and this further increases the reach of Google Maps indirectly. In the case of Waze, the current API only enables external URLs to invoke the Waze client application. Furthermore, Waze does not have the marketing budget and connections that Google does. This is crucial: Google Maps became ubiquitous only after the iOS incorporated it by default.

All these issues are solvable. If Waze can afford more map editors, increase its map database and develop a rich API, reach metrics will explode. Just imagine a Waze with the same amount of maps as Google Maps: many would replace Google Maps and migrate to Waze, due to the social features and additional relevant information about traffic and nearby interesting locations.

As for Waze's current metrics, we can refer to a post in their blog (February 2013) to get a better idea of its current size. In 2012, Waze was made by a community of 36 million drivers who shared more than 90 million user reports. This shows that Waze is growing its user database at an amazing rate: by the end of 2011, it only had 10 million users. Editors (users who are active in sending reports) were also increasing quickly: a 40% month over month increase was reported by the end of last year. By now, the company should have a 50 million user database.

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Implications for Google: "Buying Waze is all defense but great defense wins championships"

At first glance, this acquisition seems nonsense because Google already has Google Maps, the most widely used map application in the world. If compared with Google Maps, Waze is a baby in terms of metrics. Furthermore, if the acquisition price is $1.3B and we assume that there are about 50 million Waze users by now, Google would be paying $26 dollars per user, which is way too expensive.

But things make more sense if we assume that a post-acquisition Waze would have access to Google's marketing budget and Google Maps database. By having a more complete base map, Waze could accelerate the speed of its user database growth.

How much is Waze worth?

We know that the Waze user database grew to approximately 50 million users from 36 million users in half a year. This represents an astonishing 38.9% growth rate in half a year. If we assume that the growth rate will stay the same until Waze reaches 150 million and we also assume that the acquisition by Google will have no effect on Waze's user growth rate (which is highly unlikely), Waze will have approximately 70 million users by the end of this year. By mid 2014, Waze will reach 100 million users and by the beginning of 2015, 150 million users.

Let us assume the worst scenario to obtain an estimate of Waze's potential revenue. I assume that the user base will stop growing once it reaches 200 million users (by the end of 2015). Furthermore, assuming that an average user will check her Waze twice a day (60 times per month), 200 million users are equivalent to 12 billion impressions per month.

How much does Waze charge as cost per mile (CPM)? I checked the Waze pricing wizard to obtain a reference. I am based in Japan and therefore Waze's maps are quite poor in content. Based on my location, Waze suggested a bid of $1.00 - $1.10 (Waze uses a bidding system). This confirms that my location map is very poor (the lowest bid is $1/CPM). To be conservative, let's assume that for 1000 impressions Waze obtains, on average, $1.5 and spends 20 in operating costs. This leads us to a $1.3/1000 impressions potential income. Under these assumptions, Waze can generate $7.5M per month in advertisement revenue ($90M per year), or $6.5M per month in net income ($78M per year).

Notice that my assumptions are very pessimistic, to say the least. After all, I am assuming that Waze's user base will stop growing after it reaches 200 million users! But it is always good to analyze the "worst scenario." And under this scenario, it would take Google 16 years and a half to recover its investment.

A 0% return in 16 years does not sound attractive at all, but at least this deal sounds more reasonable than other examples in the industry. Unlike Yahoo's (NASDAQ:YHOO) acquisition of Tumblr or Facebook's acquisition of Instagram, I am more or less sure that Google will eventually recover its premium here. Furthermore, we ought to keep in present that Google is not buying Waze at its popularity peak. There is plenty of room for future growth.

Finally, this acquisition is very strategic if we also take into consideration the implications for Google competitors: Facebook and Apple. As Quartz cleverly notes, Apple really needed something like Waze to compensate for the poor performance of Apple's iOS 6 mapping app launched in September 2012. And Facebook needed Waze's user data to improve its mobile advertising.

By making Waze not available to Apple and Facebook, Google may have taught us a superb lesson about business strategy. Indeed, Google did not need Waze but its competitors did. And now that Google owns Waze, Google Maps is virtually unbeatable. Like Stocktwits founder Howard Linzen summarized, buying Waze is all defense but great defense wins championships.

Final Remarks

View: Positive

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.